Does corporate governance quality affect analyst coverage? Evidence from the Institutional Shareholder Services (ISS)

Abstract

We examine the impact of corporate governance quality on the extent of analyst coverage. The evidence based on nearly 3000 firms indicates that more analysts are likely to cover firms with weaker corporate governance. In particular, as corporate governance quality falls by one SD, analyst following increases by 11.40%. Our evidence is consistent with the notion that poor governance results in a wider divergence between the stock’s market price and the fundamental value. Analysts prefer to cover companies with poor governance because it allows them to generate trading commissions by offering shareholders a particularly compelling story about why a stock’s fundamental value and the current price differ.

Keywords:

• corporate governance
• analyst following
• analyst coverage
• governance mechanisms

JEL Classification:

• G34

Notes

¹ We start our sample period in 2001, which is the earliest year the data are available. We end the sample period in 2004 because, after 2004, ISS add several governance attributes to the database, making it difficult to compare the additional data after 2004 with the earlier period. For consistency, we select our sample period from 2001 to 2004.

² SIC codes 6000-6999 and 4900-4999, respectively.

³ When we exclude firms with no analyst coverage, the sample size is 4601 firm-year observations with 2372 unique firms.

⁴ The complete list of the fifty-one governance standards and their eight categories can be found in Jiraporn et al. (2011, 2012, 2013) and Chintrakarn et al. (2013). Similar information about the ISS governance standards is also available for download at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1634662 and http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2062104

⁵ Industry adjustment is accomplished by subtracting the industry median from the value of analyst coverage. Industry classification is based on the first two digits of the SIC.

⁶ We obtain qualitatively similar results without log form of Governance scores. The results are available from the authors upon request.

⁷ The SD of the log of Gov-score is 0.286. We multiply 0.286 by −2.217, the coefficient of Ln (Gov-score) in Model 1, and obtain −0.634. Given that the average number of analysts in the sample is 5.56, a drop of 0.634 analysts equals an 11.40% decline (0.634/5.56).